Term Vs Permanent Insurance
The question whether you should purchase permanent life insurance (including whole life, universal life, variable universal life, and indexed universal life) or term life insurance has been debated for a very long time. The entire whole life vs term life debate can be very polarizing.
While both sides of the debate make some good points, in the end the answer is most likely to be depend on your personal financial goals and situation. For some, a term life policy may be the better choice, while for others permanent life will work better. In some cases, a mix of both types of life insurance may be optimal.
Term Life Insurance
Term life insurance is usually much less expensive, at least in the short run, than permanent life insurance because it does not feature a cash savings component and it is only guaranteed for a certain period of time.
Unlike permanent life insurance, when your term life insurance policy expires, you will need to take another life insurance medical test and re-qualify to purchase a new policy. Alternatively, you may also have the option of renewing your term policy annually. However, annual renewable term gets very expensive over time and will be cost prohibitive.
Term Life Insurance Pros
Because term life is initially cheaper than the cost of whole life insurance, it is favored by individuals who need insurance only for a specified period of time and by those whose finances are not sufficient to purchase permanent life insurance.
Another term life benefit is it can be bought for short or long periods of time, for instance 5, 10, 20 or 30 years. This way you can tailor it to your need, such as the length of your mortgage or based on your youngest child.
Typically, younger adults opt for term life insurance, given that they may not have the financial wherewithal to purchase as much permanent life insurance as they would like.
Additionally, individuals insuring risks that will go away over time, for instance a home mortgage, may prefer term life because once the risk against which they are insuring (in the case of a home mortgage, the danger that your survivors will not be able to make payments on the house if you were to pass away) has evaporated, so too does their obligation to pay to insure that risk.
Permanent Life Insurance
Permanent life insurance combines insurance coverage with a cash value account that accumulates cash value over time.Permanent life is also known as cash value life insurance.
Cash value life insurance offers several benefits, including the benefit of growing your cash value in a tax favored environment.
Permanent life is typically more expensive than term life, especially for young, healthy individuals. However, over the longer-term, the actual cost of ownership of permanent life can be lower than term, as this type of insurance typically features a guaranteed premium payment amount, while term life premiums rise substantially for older purchasers.
Additionally, because permanent life offers a guaranteed premium amount that remains in force as long as premiums are paid, individuals who suffer a health ailment can retain such insurance at the guaranteed premium amount, as opposed to having to pay the higher rates that they would be charged if they were subject to a health exam before being able to purchase life insurance.
Permanent life insurance Pros
The potential for guaranteed growth of the cash account:
Whole life insurance policies typically guarantee the growth of the funds in your cash value account.
Although not guaranteed, mutual insurance companies typically pay life insurance dividends, which can add to the growth of your cash value.
In recent years, the growth of cash value accounts in such policies has been highly competitive with other cash equivalent savings vehicles.
Premium payment options:
Unlike term life, permanent life policies allow funds in the cash value account to be used to pay premiums, enabling you to keep the policy in effect even if you aren’t making regular premium payments.
You can also choose limited pay life insurance, which works similar to term life in that you can design the policy to be paid up after a specific number of years. That way, you get permanent insurance coverage but no premium payments are needed after the intial pay period.
Funds in the cash value account of a permanent life insurance policy growth tax-deferred, making these policies attractive to individuals looking to set aside extra amounts for goals such as retirement or other long-term objectives.
The ability to access funds in the cash value account tax-free:
Most permanent life policies allow you to access funds in the cash value account in the form of policy loans or partial withdrawals.
Funds withdrawn from the cash value account can be taken out free of taxes up to the amount you have contributed to the policy.
Life insurance loans are another option. You can borrow against your cash value and take out a loan up to 90% of the policy’s cash surrender value. Since it is a loan, there are no taxes due. Then you can use the money for whatever and however you want.
Selecting Between Term Life and Permanent Life
Term life insurance works well for situations where the need for insurance is likely to diminish or disappear altogether over time.
While a home mortgage is a commonly cited example of such a scenario, other examples could be paying for a child’s college education or paying for your survivor’s expenses in the case of your untimely death, especially if their income is not sufficient to pay expenses and substantial assets to help support them if such an event occurs have not been accumulated.
It is important to understand that given the wide variety of uses for life insurance, in many cases the need for coverage does not go away over time.
If you purchase term life, it can become prohibitively expensive to continue to renew such policies in your later years, especially if there are health issues involved. As a result, individuals who expect to need coverage later in life are often better served by either purchasing permanent life right away if possible or by purchasing term life that is convertible to permanent life insurance. Such policies typically offer you the opportunity to convert the policy to a permanent one within the first few years of the term.
Younger individuals who want to starting buying permanent life insurance but who don’t have the income to do so may want to consider buying a mix of term and permanent life. As their income rises, they can purchase more permanent life coverage. Additionally, in many cases, they can use any policy dividends paid by such a policy to purchase more insurance coverage as well through the use of paid-up additions.
Some other situations where you may want to consider using permanent life insurance include:
Using Life Insurance as Your Personal Bank:
Your life insurance can be used as a bank. As your cash value grows, you can access up to 90% of the cash surrender value to pay for large ticket items, invest in real estate, grab some stocks in the next market crash, start a business, etc.
Passing on wealth to heirs:
Life insurance death benefits typically transfer to your beneficiaries without personal income taxes, making permanent insurance an excellent vehicle for passing on wealth.
As a savings vehicle:
The combination of tax-deferred growth, tax free loans and tax-free withdrawals up to your basis in a policy makes permanent life insurance an attractive vehicle for setting aside funds for retirement or other long terms goals.
This is especially true if you are maxed out in qualified retirement plan contributions to your company 401(k) plan or IRA.
Because permanent life insurance acts as a form of forced savings, given that a portion of each premium payment is added to the cash value account, it can be a good way to build up excess funds that you can use for a variety of purposes.
Because many states shield life insurance assets and proceeds from attachment as a result of legal liability, these policies can be useful for asset protection purposes.
If you are worried about becoming uninsurable:
Health issues later in life can substantially raise the cost of purchasing life insurance. As a result, the guaranteed premium payment amount offered by permanent life insurance for the life of the policy as long as premiums are paid can be an attractive feature for those who don’t want to roll the dice by continually requalifying for insurance as they get older.
Paying estate taxes:
Permanent life insurance policies have long been used for the purposes of paying estate taxes, especially for estates that contain sizable illiquid assets that would be difficult for the heirs to sell quickly. Such a policy can create the necessary liquidity to pay Federal estate taxes and give heirs the time they need to sell assets at a fair price or take control of their management.
Using life insurance to fund a buy sell agreement is a great way to buy out an existing partner or partners. In addition, the life insurance death benefit proceeds provides much needed liquidity so the business is not sold at a fire sale.